SRILANKA’S ECONOMIC CRISIS

WHY IN THE NEWS?

The Sri Lankan economy has been facing a serious economic crisis owing to its Balance of Payments (BoP) problem. The country is struggling to pay for essential imports after its foreign exchange reserves saw a 70 percent drop in two years.

INFLUENCE OF COVID-19 PANDEMIC

 The ongoing pandemic has influenced all nations across the world like Sri Lanka. But there are some specific reasons for the current economic crisis in Sri Lanka.

WHY SRI LANKA IS DIFFERENT FROM OTHER COUNTRIES?

1. Downfall of GDP growth rate

• Sri Lanka is experiencing a long-term recession due to a continuous negative GDP growth The negative GDP rate worsened the economic health of the country.
• It is because of the exorbitant prices for the essential commodities which resulted in the poor consumption of goods and services. It further reduced the overall production in the Sri Lankan

2. External debt

• The total amount of debt taken by the Government of Sri Lanka is about 115% of its GDP. Before the pandemic, it was around 90-95% of the
• The entire GDP of Sri Lanka was around 85 billion
• They procured loans beyond their tolerant

3. Shortage of foreign exchange reserves

• The foreign exchange reserves of Sri Lanka have fallen from around 7.5 billion dollars to just $2 billion at the end of February i.e., falling by 70% in two years, which can barely cover two months of

4. Fiscal deficit

• The fiscal deficit is the difference between the revenue and expenses in the economy. If an economy spends 100 rupees with a revenue of 80 rupees, the rest of 20 rupees is taken as a loan and it can be termed a fiscal
• In Sri Lanka, the fiscal deficit is around 10% of the GDP, i.e., they are taking about 8 billion dollars as debt each

5. Current Account Balance

• The country is resorting to more imports as compared to Since the GDP growth is negative and there is not much production taking place to raise its exports.
• It has a negative current account balance in the range of 3-5 % indicating it is a net

6. Inflation

• The country is experiencing inflation of around 15
• The unplanned pumping of money into the economy and reduced production of goods and services fueled the inflationary trends in the
• Even the availability of goods in the market cannot be increased through imports due to a shortage in foreign exchange

WHAT ARE THE SPECIFIC REASONS THAT MADE SRI LANKA EXPERIENCE THE PRESENT CRISIS? IMMEDIATE EXPOSURE TO CRISIS

1. Influence of Covid-19 pandemic

• The tourism industry which accounts for about 10% of Sri Lanka’s GDP and the country’s third

largest foreign exchange earner has been hardly affected by the covid-19 pandemic.

• The remittances from their diaspora were stopped due to Covid-19 lockdowns and the further downfall of the global economy. It has negatively affected the foreign exchange reserves of the
• Covid-19 lockdown also negatively impacted the informal sector which accounts for nearly 60% of

the country’s workforce.

2. Poor Fiscal policy
   • The government’s ban on the use of chemical fertilizers in farming to make Sri Lanka the first

country to fully adopt organic farming, led to a drastic drop in domestic food production, pushing up food prices.

• It led to a reduction in tea exports, spices, and a shortage of food grains in the
• It subsequently resulted in long queues of people in the

LONG TERM REASONS

1. Shortage of foreign direct investment

• The country is not able to attract viable FDI from foreign
• Beyond tourism and dependence on remittances, the country has not devised better policies for improving its economic stability.
• The country is mostly depending on imports for their basic essential items and not even concentrated on improving its production
• The country attracted limited investments and that too mostly from China as part of Chinese checkbook diplomacy. The inability to repay Chinese loans finally led to the 99-year leasing of the Hambantota port to China by Sri
• Sri Lanka invited investments only in a few sectors such as real estate, tourism, Telecommunication, and ports which shrank their foreign currency reserves within the

2. Poor monetary policy

• There is a wide mismatch between goods produced and the amount of money available in the economy to procure these goods.

Fig: Table shows poor equilibrium between the money available in economy and products available in the market.

• In this scenario, the Central Bank of Sri Lanka pumped more currency despite the limited availability of the products in the
• This step worsens the economic situation and inflated the prices of even essential commodities. Because there is more money chasing few available goods which spiked the prices of the
• It further depreciated the value of the Sri Lankan currency and now, One Sri Lankan Rupee is equal to 355.36 (as of date 27^th July 2022).
• They have even canceled the student’s examination on account of the inability to procure enough

pens, papers, and pens.

HISTORICAL REASONS

1. Illegal nexus between politics and business

• Sri Lanka after its independence from the British in 1948 gave importance to the public
• The country is having constitutional multi-party socialistic republic policy. The government itself started the business with public sector
• Conflict of interest arises among people holding the positions and their personal interests which made the situation
• By 1971, there was political instability leading to a communist revolution 1971-1972.
• The civil war on account of the Tamil crisis between Sinhalese and Sri Lankan Tamils from 1971 to 2009 exacerbated the financial
• However, hidden political agenda led to backdoor postings to top positions with no meritocracy resulting in poor policy formulation and
• The vested interest never allowed private participation in its
• Consequently, the country developed the habit of depending on external loans for meeting their day-to-day operations such as providing subsidies and paying salaries to the people.
• Moreover, this external debt has not been utilized for creating capital infrastructure in the
• The World Bank recommended the nation to utilize the debt for the creation of long-term assets in the
• Education sector- The education in the country is also more confined to Arts and general education and very less technical education is given to the students. It may negatively affect the skill sets available in the market and incur low technical upgradation in the long
• In addition to this, around 80 percent of lands were under the control of the Sri Lankan
• The country has not even fully connected with the global supply chain
• The parochial interest of the Gotabaya Rajapaksa government after the Civil war in 2009 led to corrupted leaders in governance finally resulting in financial
• All these elements together come into the picture after the global pandemic and its sudden influence on the

GOVERNMENT’S STAND

• The Sri Lankan government is blaming the present condition of the country due to hoarding by the The practice of hoarding led to artificial scarcity in the economy which is responsible for the entire crisis.
• However, the government fails to address the reason behind the scarcity or why the people resorted to hoarding for meeting their essential
• The Sri Lankan government finally requested India and China to grant credits for meeting their essential
• India provided Sri Lanka with a USD 1 billion line of credit (LoC) for procuring food, medicines, and, other essential
• Sri Lanka has signed a Currency swap agreement with India and the Reserve Bank of India had announced a USD 400 million currency swap to help Sri
• Currency swap agreements are agreed for trading in their own local currencies, where both countries pay for import and export trade, at the pre-determined rates of exchange, without bringing in a third country currency like the US Dollar.
• Finally, Sri Lanka has reached IMF support despite their initial reluctance. However, IMF loans always come with conditionality which is very necessary for achieving economic stability for Sri

WAY FORWARD

1. Fiscal consolidation

• Spend money on creating capital infrastructures rather than spending on unwanted revenue
• Abide by the conditionality of IMF for better financial discipline in the long
• Develop forex reserves by reorienting its structural
• Maintain financial prudency in the overall functioning of the

• Monetary policy
  • Improved autonomy in the performance of the Central Bank is the need of the
  • Expert advice should be sought before adopting monetary measures since the untimely supply of

currency aggravated the financial status of the country.

3. Banking sector

• Independence to be provided for the banking sector to take decisions in granting loans, especially to corporates.
• Earlier, the banking sector which was completely under government control has to abide by the decisions of government authority and grant loans to those companies which are insisted by the government despite their poor financial
• It resulted in the burgeoning of Non-Performing Assets (NPA) within the

4. External sector

• Design domestic policies to attract more FDIs in various
• Devise better policies to improve corporate
• Initiate structural frameworks to start production within the country to meet the country’s needs

rather than depending on imports.

• Use the demographic potential and available skill sets in the

5. Diversification of the export policy to raise foreign reserves of the
6. Develop a virtuous cycle- Promote domestic savings and raise investments from these savings and further promote savings in the country and then further investments.
7. Always learn from the past experiences and trends of other countries to not repeat the failures and

adopt successful measures.

8. Gradual introduction of new policies to avoid economic shocks in the

For example: if the policy is better to eliminate chemical fertilizers, organic farming has to be introduced gradually as natural farming tends to give results much later. Moreover, it will not affect the food security of the country too.

HOW SRI LANKAN CRISIS INFLUENCES INDIA?

1. Crisis as an Opportunity

• India, the largest democratic country, needs to be extremely patient and engage with Sri Lanka more regularly and
• There is also a need to step up our people-centric developmental activities while staying away

from any interference in Sri Lanka’s domestic affairs.

• The crisis should be used as an opportunity to negotiate with Sri Lanka to abandon their swinging attitude between China and India according to the
• For example- Still Sri Lanka is confused with their oil infrastructure policy at Trincomalee with the Indian
• The strategic position of Sri Lanka in the mid of the Indian Ocean make the country more vital to

2. Geo-political significance

• The IMF loans with conditions will necessarily improve the Sri Lankan financial
• However, the western favored IMF tends to devise policies that might result in the Dominance of western nations in Sri
• It will negatively impact India’s strategic interest by occupying the region by another power

instead of China in the region.

3. Devise better policies to help neighboring countries of

• For Instance, the non-reciprocal assistance to other countries under the “Gujral doctrine” of India bridges the trust deficit and can overtake China’s Chequebook

4. Mass exodus of Sri Lankans raises the refugee problems in
5. Chances of rising anti-social elements and terrorism can happen mostly in poorly governed

• For instance- The Easter attack in 2019 in

6. Indian investors who are doing business and projects on Sri Lankan soil are at
7. Moreover, the bilateral trade and exports of around 4 billion dollars might affect
8. Cultural interest- India is having its cultural connections with Sri Lankan India often demanded more political representation for them and active implementation of 13 th Amendment to the Sri Lankan Constitution. In this situation, the Sri Lankan Tamils would also face a lot of struggles due to the current economic crisis is a major concern for India.

CONCLUSION

The need of the hour is to undertake structural reorientation of its economic policies. The expert advice in the policy formulation and the subsequent implementation can act as a roadmap for Sri Lanka’s economic development. Moreover, India should use the current situational opportunity strategically along with preparing for the challenges also.

Practice Question

The strength of an economy depends on both internal and external strengths. Critically examine the lessons that India must learn from the recent Sri Lankan economic crisis and explain its implications on India.

(250 Words, 15 Marks)